As Erik goes deeper into real estate, he comes across a concept that he was unfamiliar with and wants to share in this episode. Listen to Erik shares the pros and cons of a master lease when investing in real estate.
Erik J. Olson (00:02):
In real estate, there is a concept known as master leases. What is happening? This is Erik J. Olson. I’m getting deeper and deeper into real estate investing in July. I went to Miami and I attended Grant Cardone’s real estate summit for the second time in a year, I went in August of 2021 and again, July of 2022. And the second time I brought my wife and now we are really looking at a lot of deals. And one of the deals that I came across recently, it looked, it looked pretty good. So I started to dig a little bit deeper, asked the listing Asia more questions. And and I, I, I came across the concept that I was unfamiliar with and I wanted to share with you. So in, in the deal, there are, there are 10 units. Two of them are commercial. Eight are residential. It’s a three story building.
So at the bottom for you, I have two commercial spaces. And then above you have eight residential units. And it, like I said, it looked pretty good. So I was interacting with the agent. I was talking to him, I was sharing emails. He was sharing financials. And I noticed that one of the commercial units was occupied by the current owner. And when I went to ask if, oh, but, but somewhere I can, when the financials are something I said vacant. So I asked the question, well, is it vacant or is he gonna occupy it? And the answer that I got back was, oh, the owner will occupy it as part of his master lease. Now this is the second time that this agent referred to a master lease. And I was like, ah, I, you know, okay, I’m, I’m not a real estate, like expert yet.
I’m getting there, I’m working on it, but I don’t have all the answers yet. And so I was like, yeah, I wonder what, why does he keep saying master lease? Why not just say lease? And what I realized was that there’s probably a different definition for a master lease than a lease. And my wife was like, Hey, why, why don’t you Google it, Erik? Duh <laugh>. So I did. And what I found out is at a master lease is where someone will lease the entire building, like all the units themselves. So there’s one big master lease between the owner of the building and the master lease holder. And then the lease, the master lease holder would then sublease individual units to the tenants. Now, is that a good thing or a bad thing? Now on the, on the pro side with the master lease, you’re pretty much guaranteed that you’re going to get the rent that you require as the new owner.
So if I’m the new owner and have a master lease with someone or the old owner, then that I already know what what’s gonna come in. And that you know is regardless of whether individual units are vacant or not, that’s his problem now, not my problem, right? So the liability of vacancies goes away because the master lease holder has that liability. If you structure the lease properly, now the cons. So the cons are the master lease holder could raise the rents of the individual units and probably not pass those on to you. Now, again, it could, you know, depending on your master lease agreements, you can come up with whatever arrangement you want. But the idea is that they sublease for at their own risk for whatever price that they want. So if they raise the rent as the owner, you don’t get to benefit in that.
Now that that’s a major negative, because that is a source of, of new revenue and new value that you can use to offset your investment and to make your investment make a lot more sense. That’s the upside of the investment. Now another con is that you have one person, well, there’s two other cons con number one. Now you have one lease. I’d rather have 10 l eases frankly than one cuz now I’m dependent on one person, right? So you have more liability with this one person. And then the second con is that someone else is controlling your deal, right? So if you’re gonna put up potentially a lot of money, you know, and these kinds, 10 units is well over a million dollar investment. Not that I have it, but I’m gonna borrow it, but I’m still on the hook for it, right? But if I’m gonna put up all this money, time, energy to acquire a piece of property and then there’s one master lease.
And that one person now controls the, my deal. He controls what’s going on there on the property tenants in and out interactions with tennis. He’s a middle man. That’s not good. You do not want that. So yes, there are some pr os. I would be very concerned. I am very concerned about the cons. As a matter of fact, I’m so concerned that I’m walking away from that deal. It’s just not worth it. So if you’re getting into real estate investing Hey look, be, be aware of this concept of the master release. Again, may, maybe it works out for you for me. I, I don’t want that. I don’t want a middleman between me and the tenants. So I’m gonna share with you more things that I’m warning during this journey to investing in real estate, by the way, this is called the Journey to $100 Million, frankly, I don’t really care if it’s the company that gets a hundred million dollars, that real estate that gets to a hundred million dollars.
I just wanna see a 100 followed by a whole bunch of zeros to make a hundred million. So I’m trying to get at it from a couple different angles now, right? The valuation of the company, the sale of the company the revenue of the company. I just wanna hit it first. Just, I just wanna see that on paper and then, and then we can argue about whether that’s what we really meant or not. So we’re trying to build this thing up. There’s a business angle, there’s a real estate angle. There’s, there’s a lot of different angles. And I, I, I, I did that intentionally, but I also have to be very concerned and aware that I can’t be
Distracted. Right. So the main thing has to remain the main thing. And the main thing is what’s on my shirt right now, Array Digital. That’s the main thing. These other things they’re secondary. So that’s another thing to, to keep in mind whether it’s real estate or anything else. Right. Keep focus on the main thing and keep it first.